How Europe is overcoming the crisis

Klaus Regling, Managing Director, ESM

TsingHua University

Beijing, 3 June 2015

I. What went wrong in the euro area?

II. Five lessons from the euro crisis

1. Reduce vulnerabilities, implement reforms

2. Strengthen governance of euro area

3. Create a stronger European banking system

4. An active monetary policy

5. Establish a crisis mechanism

III. Restoring growth in the euro area

How Europe is overcoming the crisis

1

I. What went wrong in the

euro area?

2

Eight reasons for the sovereign debt crisis

3

1. Member States did not fully accept the political constraints of being in EMU

2. Transition to permanent lower interest rates

3. Economic surveillance too narrow

4. Methodological problems with calculating structural fiscal balances

5. Insufficient control of data by Eurostat

6. Financial market supervision mainly national

7. No crisis resolution mechanism

8. Biggest financial crisis in 80 years

II. Five lessons from the

euro crisis

4

1. Reduce vulnerabilities,

implement reforms

5

Five lessons from the euro crisis

Deficit reduction policies are paying off

Source: European Commission, Economic Forecast – Spring 2015

Selected comparative fiscal balances (% of GDP)Fiscal balance in programme countries (% of GDP)

6

-25

-20

-15

-10

-5

0

5

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

*

* Actual figure for Ireland in 2010: -32.4%

-14

-12

-10

-8

-6

-4

-2

0

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Euro area USA Japan UK

Internal devaluations are restoring competitiveness

■ Thanks to the convergence in competitiveness, costly external imbalances in the periphery havedisappeared

Current account balance (% of GDP)

Source: EC European Economic Forecast – Spring 2015

Nominal unit labour costs (2000=100)

7

-20

-15

-10

-5

0

5

10

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

90

100

110

120

130

140

150

EFSF/ESM programme countries are the reform champions

8

■ Greece, Ireland, Portugal and Spain are in top 5 of 34 OECD countries with

regard to implementation of structural reforms.

Source: OECD report Going for Growth for 2015

Ranking takes into account responsiveness to OECD recommendations on

structural reforms in key policy areas

Ranking in OECD report

1. Greece

2. Ireland

3. Estonia

4. Portugal

5. Spain

“Euro area countries under financial

assistance programmes are among the

OECD countries whose responsiveness

[to the OECD’s structural reform

recommendations] was highest and also

where it most increased compared with

previous period.”

- Going for Growth (OECD Report)

Reforms include improved business regulations

9

■ Greece, Spain and Portugal have recorded significant progress in the World

Bank’s Doing Business ranking since 2010

■ The ranking measures the ease of starting and operating a local business

1. 2. 4. 5. 16. 18.

Source: the World Bank, Doing Business ranking,

2010 and 2015

109

62

48

61

3325

0

20

40

60

80

100

120

Greece Spain Portugal

2010 2015

2. Strengthen governance of

euro area

10

Five lessons from the euro crisis

Improved economic policy coordination

■ Euro governments adopted more comprehensive and binding rules fornational economic policies

• Stability and Growth Pact has stricter rules on deficit and debt

• Less room for political interference by national governments

• Balanced budget and debt rules now also in national legal systems

• European Semester: yearly cycle of economic policy coordination

• Annual country-specific recommendations

• Stronger emphasis on avoiding macroeconomic imbalances

• Eurostat authorised to verify national data

11

12

How can goverance be strengthened further?

■ Additional steps in euro area integration likely

■ Proposals under discussion:

• a euro area finance minister

• a “fiscal capacity” for the euro area

• joint decision-making for structural reforms

• more democratic accountability and legitimacy

■ Implementation legally and politically difficult and time-consuming

3. Create a stronger European

banking system

13

Five lessons from the euro crisis

A stronger banking system

Three new European supervisory authorities: EBA, EIOPA and ESMA

New ESRB monitors macro-prudential risks

Financial market reforms

• “Basel III” (CRDIV/CRR) is being progressively implemented

• Huge capital increase for banks – Core Tier 1 capital ratios are now 9% or more

• EU banks added €560 bn to their capital since 2008

Banking Union started in November 2014

• Single Supervisory Mechanism (SSM) operational since 4 November 2014

• Bank Recovery and Resolution Directive (BRRD) will create a uniform framework for

bank recovery at national level with bail-in as a key instrument

• Single Resolution Mechanism (SRM) with Single Resolution Fund (SRF)

• ESM Direct Recapitalisation Instrument available

14

4. An active monetary policy

15

Five lessons from the euro crisis

Monetary policy

■ SMP: from 2010 to 2012, ECB purchased euro area sovereign bonds (over €200 billion) insecondary markets

■ LTRO gave banks unlimited liquidity: in December 2011 and March 2012, around €1trillion allotted in 3-year loans

■ OMT announcement in September 2012 calmed the markets

■ New package in June 2014

• Targeted LTRO (at least €400 billion available lending capacity) designed to stimulatelending to small- and medium-sized companies

• Negative deposit rate

■ Programme for buying ABS and covered bonds announced in September 2014

■ Quantitative Easing programme announced in January 2015

• Asset purchases expanded to include euro area government bonds

• Combined monthly purchases of €60 billion from March 2015 to September 2016

16

QE asset purchases by the ECB started in March 2015

The ECB’s balance sheet is to reach €3.4 trillion in Sept. 2016

17

5. Establish a crisis mechanism

18

Five lessons from the euro crisis

19

EFSF and ESM: mission and scope of activity

Mission : to safeguard financial stability in Europe by

providing financial assistance to euro area Member States

Instruments

LoansPrimary Market

Purchases

Secondary Market

Purchases

Precautionary

Programme

Bank recapitalisations

through loans to governments

All assistance is linked to appropriate conditionality

EFSF and ESM finance their activity by issuing bonds or other debt instruments

Direct bank

recapitalisation

only

■ Support for five countries (EFSF: Ireland, Portugal, Greece; ESM: Spain and Cyprus)

• Combined lending capacity: €700 bn

• Committed amount to the five countries: €238.6 bn

• Disbursed so far: €232.5 bn

• EFSF/ESM disbursed three times as much in Europe as IMF in same period globally

• Ireland, Spain and Portugal have exited their programmes

• Macroeconomic adjustment programmes for Greece and Cyprus ongoing

EFSF and ESM lending

20

1. All Member States have remained in the euro area

2. EFSF/ESM programmes promote fiscal adjustment and structural

reforms

3. EFSF/ESM lending supports return to debt sustainability

4. The euro area has a lender-of-last-resort for sovereigns

Benefits of EFSF/ESM lending

21

Loans are euro area solidarity

In € billion As percentage of

GDP

As percentage of

total primary

expenditures

Cyprus 0.24 1.5 3.4

Greece 8.58 4.7 8.6

Ireland 0.68 0.4 1.1

Spain 2.43 0.2 0.6

Portugal 1.27 0.8 1.7

Potential savings of EFSF/ESM financing vs theoretical market cost (for

2013)

Calculated using theoretical market spread of 5- and 7-year bond of each country

matching the EFSF/ESM maturity profile on the 3 months before and after each country

requested support. This is compared with the equivalent EFSF/ESM funding cost.

22

Benefits of EFSF/ESM lending

A comprehensive response to the euro crisis

1) Reduce vulnerabilities, implement reforms

■ Macroeconomic imbalances are disappearing

■ Strong growth in programme countries

2) Strengthen governance of euro area

■ More comprehensive and stricter rules for policy coordination and surveillance

■ Rules need to be credibly implemented

3) Create a stronger European banking system

■ European banks have doubled their capital since 2008 and now have a Core Tier 1 capital ratio of 9%

or more

■ Banking Union is being established

4) An active monetary policy

■ The ECB’s unconventional measures have ensured sufficient liquidity and removed the threat of

deflation

5) Establish a crisis mechanism

■ EFSF and ESM have disbursed €232 bn to Ireland, Portugal, Greece, Spain and Cyprus

■ EFSF/ESM loans support adjustment and debt sustainability

23

24

III. Restoring growth in the euro area

Focus on growth

■ Economic recovery in euro area is boosted by external factors and policy measures

• fiscal headwinds disappear

• lower energy prices boost consumption and investment

• weakening of euro exchange rate supports net exports

■ Structural reforms are crucial for raising potential growth and they are a precondition for

the effectiveness of monetary and fiscal policy

• Adjustment programmes include long lists of structural reforms

• European Commission and Council adopt recommendations for each Member State on

ways to stimulate growth and create jobs

■ Europe has a lot to offer for education and training

25

GDP growth is picking up in all programme countries

Source: EC European Economic Forecast – Spring 2015

26

GDP growth, year/year (%)

-10

-8

-6

-4

-2

0

2

4

6

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Focus on growth: more can be done

27

■ Juncker Plan: creation of European Fund for Strategic Investments (EFSI)

• A guarantee of €16 billion will be created under the EU budget; the EIB will commit

€5 billion

• The Fund has the potential to yield €315 billion of financing over three years,

thanks to estimated multiplier effect of 1:15

• EFSI will support strategic investments in infrastructure, education and research,

as well as support risk finance for SMEs and mid-cap companies

■ Further measures are needed

• Single Market should be completed to boost growth

• Proposed Capital Markets Union would reduce reliance on bank funding in Europe

• Private debt deleveraging should be promoted

GDP per capita growth comparison

Source: Spring 2015 European Commission forecast

28

GDP/capita growth since 1994 has been very similar in US and EU

Average GDP growth per capita,

1999-2008

-6

-5

-4

-3

-2

-1

0

1

2

3

4

94 96 98 00 02 04 06 08 10 12 14 16

Euro area US

euro area 1.6

US 1.6

Economic well-being shows more than GDP/capita

29

■ A study was recently conducted by Boston Consulting Group on economic well-being around the world

■ The study defined well-being through three elements that comprise 10 dimensions:

• Economics: income, economic stability, employment

• Investments: health, education, infrastructure

• Sustainability: income equality, civil society, governance and environment

■ The study developed two coefficients providing relative indicators of how well a country has converted

its (i) wealth and (ii) growth into the well-being of its population

Source: Boston Consulting Group, 2015

Sustainable Economic Development Assessment

0.961.04 1.07 1.08

1.17

0

0.2

0.4

0.6

0.8

1

1.2

1.4

US France EAaverage

Germany Finland

Wealth-to-well-being coefficient in selected countries in 2015

■ From 2006 - 2013, the US and Germany both

recorded an average GDP growth rate of 1.1%

■ Germany’s ability to convert growth into

economic well-being was equivalent to an

economy growing at an average rate of 6.2%

■ In the case of the US, it was equivalent to an

average growth rate of only 0.5%

How the US and Germany have translated

growth into well-being

Labour markets

30

■ Since 2000, employment rate has increased in euro area but fallen by around 6 p.p. in

the US

■ Participation rate in euro area stabilised after rise until 2009; in US continues to

decline

Employment rate change since 2000 (%) Participation rate change since 2000 (%)

Age group: 15+ for euro area, 16+ for US

Latest observations: Q4 2014

Source: Eurostat, BLS and ESM calculations

Age group: 15+ for euro area, 16+ for US

Latest observations: Q4 2014

Source: Eurostat, BLS and ESM calculations

-8

-6

-4

-2

0

2

4

2000 2002 2004 2006 2008 2010 2012 2014

Euro area US

-5

-4

-3

-2

-1

0

1

2

3

4

2000 2002 2004 2006 2008 2010 2012 2014

Euro area US

I. What went wrong in the euro area?

II. Five lessons from the euro crisis

1. Reduce vulnerabilities, implement reforms

2. Strengthen governance of euro area

3. Create a stronger European banking system

4. An active monetary policy

5. Establish a crisis mechanism

III. Restoring growth in the euro area

How Europe is overcoming the crisis

31

32

Contact

Wolfgang Proissl

Chief Spokesperson

Phone +352 260 962 230

w.proissl@esm.europa.eu

Luis Rego

Deputy Spokesperson

Phone +352 260 962 235

l.rego@esm.europa.eu

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@ESM_Press

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